Wednesday, January 23, 2013

The technique of momentum trading

Momentum
trading, the focus of the technical discipline utilized by the Momentum Strategies Report, is based on
three major pillars:

1.Market trend/momentum

2.Internal trend/momentum

3.Fundamental trend/momentum

Momentum
trading is based on the axiom that a “trend in motion tends to stay in motion
unless acted upon by an equal and opposite force.” When the broad stock market is in a bullish
trend as defined by expanding new 52-week highs and shrinking 52-week lows on a
rate of change basis, the best individual stock trades tend to be those with
little or no overhead resistance. In
other words, stocks with strong chart patterns in clear rising trends.

One of the
best ways of identifying top-flight momentum stocks is by starting with the
3-month or 6-month daily chart, then expanding the time frame to at least a
4-year monthly chart. Ideally, of
course, the stock in question should have strong earnings and revenue growth with
bullish analyst expectations for the next 3-4 quarters. Once the company’s fundamental strength has
been ascertained, it’s time to focus on the stock’s technical strength.

Technical
strength is best measured by taking a relative strength survey of the stock in
relation to both the broad market S&P 500 Index as well as the industry
group it trades in. You’ll do well to
ask yourself, “Is the stock showing relative strength on a short-term as well
as an intermediate-term basis?” If the
answer is yes, then proceed to the next step of evaluating the structure of the
charts.

Let’s take
one of our more recent stock picks, namely PulteGroup (PHM). When we first evaluated this stock a few
weeks ago in the newsletter it was clearly that the 3-month daily chart had a
bullish structure. You can still clearly
see this in the following chart example.

Even more
importantly, PHM had/has a bullish 4-yearly month chart structure with no
overhead resistance/supply in sight (see below).

An even
longer-term graph depicts chart resistance beginning around the $24-$25
area. But for short-term trading
purposes a 4-year monthly chart will typically suffice for giving you a good
idea how much upside potential and forward momentum a stock will enjoy in a
confirmed bull market.

Now
compare this to another stock in the home building industry, namely D.R. Horton
(DHI). Unlike PulteGroup, DHI has more
near-term overhead chart resistance to contend with. You can see this resistance around the 22.00
level beginning around late October/early November in the 6-month chart shown
here. This resistance is even more
visible from the vantage point of the 4-year monthly chart (not shown). Not surprisingly, DHI has lagged the home
construction industry group for this rally and hasn’t yet made a new 52-week
high, unlike PHM.

The lesson
here is that it usually pays to do relative strength and momentum studies when
selecting stocks for trading and investing.